Total inventories across all levels of business fell for the 10th straight month in June. The 1.1% decline was bigger than the 0.9% decline expected by the consensus of economists, and follows a downwardly revised 1.2% drop (was down 1.0%) in May.
Inventories can be a big swing-factor in GDP growth, and the revision to May and the lower-than-expected number for June would seem to point to a downward adjustment to the second quarter GDP numbers when the next revision comes out.
Overall, lower inventories is a good thing, since it points to the need to replenish them in the future and in the process boost economic growth. June also saw a 0.9% rise in overall sales from May, which is a very welcome sign and a reversal of a very nasty trend that has lowered sales by 18.0% over the last year. The combination of rising sales and falling inventories lowered the inventory to sales ratio to 1.38.
As shown in the graph below (click here for a more legible version: http://www.census.gov/mtis/www/mtis_current.html), the inventory-to-sales ratio had been in a secular decline until this recession hit. A year ago the ratio was near its all time low at 1.26 — then the credit crunch hit and the ratio spiked to 1.46 in December and January, and has since started to decline again. That level was the highest since April of 1996.
The ratio is important since if businesses see that inventories are too low, they will start to ramp up production to refill them. The decline in the ratio is encouraging, but we still have a ways to go.
All three levels — manufacturers, retailers and wholesalers — saw declines in the month. However at the manufacturing and wholesale levels the ratios remain significantly higher than a year ago.
From a cash flow perspective, lower inventories (in absolute terms, not relative to sales) are good since it frees up working capital. In this environment, companies can use all the working capital they can get. For many businesses, the ability to turn over their inventories is just as important to them as the gross margins they earn on each sale.
At the retail level, it depends greatly on the type of store you have. A grocery store like Kroger’s (KR) cannot sit on the same fresh raspberries for a year; rather, they depend on replenishing their stock often and sell at relatively low mark-ups.
At the other extreme, a jewelry store like Tiffany’s (TIF) will sit on its inventory for a long time, but get a big mark-up on each sale. The secular decline in the ratio had been driven by improved information technology that has allowed for companies to adopt just in time inventory systems.
Overall, the decline in the inventory-to-sales ratio is a welcome sign, but it is not yet cause for celebration. I’m not sure if the secular trend is still intact longer term (it had flattened out for about 2 years before spiking), but there is nothing to suggest that the new “normal” should be significantly higher than the levels of two years ago.
This implies that the inventory to sales ratio needs to come down more. That, in turn, suggests that production will not increase as fast as sales do — if and when sales start to pick up significantly.
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Read the full analyst report on “TIF”
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